The Central Bank of Egypt (CBE) announced that it aims to reduce the inflation rate to 13% (+/-3%) by the end of the last quarter (Q4) of 2018. It is the first time that the CBE announces its targeted inflation rate over a specified period of time.
Daily News Egypt raises several questions on this issue: can the CBE succeed in achieving its target on time? How can the CBE achieve this 13% inflation rate down from about current 35% in less than a year and a half? What are the conditions that must be provided to help the CBE achieve its goal? What are the other countries’ experiences in dealing with inflation, especially those with similar conditions like Egypt?
We will try to shed light on the topic.
Can the CBE succeed in its mission?
Mohamed Abdel Aal, a board member of the Suez Canal Bank, said that the state’s announcement represented by the CBE to reduce inflation rate to 13% (+/-3%) by the end of Q4 of 2018 means that the CBE, for the first time in its history, will apply an inflation targeting policy. This policy means targeting a specified inflation rate at a certain period of time.
He added that the main objective of the CBE’s monetary policy in the next period is to stabilise inflation in an attempt to achieve a longer-term goal of price stability.
But can the CBE succeed in achieving this goal?
Abdel Aal said that the CBE can achieve a relative success, because we have not been informed with its long-term plan for inflation. We do not know whether the CBE will stop at the announced target or not as it did not disclose that, he said.
According to Abdel Aal, the achievement of this goal relies on the CBE’s ability to control other factors that may affect inflation, noting that there are important determinants that can help or hinder the CBE to achieve its goal.
Abdel Aal pointed out that targeting a certain rate of inflation may adversely affect the country’s economic growth. It also contradicts with the exchange rate’s stability and the reduction of unemployment.
He stressed that this step requires great efforts in coordinating between the monetary, financial, and investment policies of the state.
“The most important element that can help the CBE to achieve its goal is gaining the full independence in using its tools,” according to Abdel Aal.
He explained that the success of the CBE depends on its independence level, and the full freedom to use its tools. Abdel Aal noted that pressuring the CBE, such as financing the budget deficit, supporting interest rate and exchange rate or financing the public sector, can negatively affect its plan to reduce inflation.
Does this mean that the CBE can fail in achieving its goal?
Abdel Aal ruled out the failure of the CBE to achieve its gaol since most of required conditions and elements are available.
Abdel Aal point out that the scheduled time set by the CBE to reach its inflation target is very short and it would be better if it lasted for at least two years.
He explained that the long term plan provides a better opportunity for the CBE to absorb shocks of collective short-term supply or demand, which requires high prediction capabilities.
Other countries’ experiences
According to Abdel Aal, other countries that maintain an inflation rate of 15-25% for more than three years do not achieve reasonable inflation rates permanently.
Since 2001, some countries have begun to target specific inflation rates, such as Norway at 2.5%, New Zealand 0-3%, and Canada at 1%, he said.
On the other hand, some developing countries, despite all the economic problems they undergo, have achieved successes and positive steps in their targeting of low inflation rates, such as Chile, which has similar circumstances as Egypt, except that it did not suffer from a state deficit.
Have any countries with similar conditions like Egypt succeeded in achieving target inflation rates?
Of course, there are several models for countries with similar conditions that have achieved great successes in targeting inflation, such as Brazil. It reduced its inflation rate from 535.9% in 1980-1991 to 7.9% in 2000, 6.9% in 2001, and 6% from 2002 until now.
South Africa also managed to reduce inflation from 14.7% in 1980-1991 to 2.5% in 2000, while inflation now ranges between 3 and 4%. Mexico also reduced inflation from 61.7% to 4.5%.
The rate of inflation in four Latin American countries was 200%, and they succeeded in reducing it to 10% and then to 3%-4% since 2001 until now.
Peru has very similar conditions to the Egypt, where the exchange rate after floating its currency affecting inflation. But the country managed to reduce it.
Three conditions for success
Abdel Aal believes that there are three main conditions to be met: full independence of the CBE and a mandate to achieve its objectives; a clear and strong coordination system between financial, monetary, and investment polices; and transparency of the procedures.
According to banking expert Hani Abu El-Fotouh, the CBE is responsible for the management of the monetary policy in Egypt, under the Central Bank Law and the banking system No. 88 of 2003. The inflation file tops the CBE’s priorities, according to the bank’s recent several statements as well as the International Monetary Fund’s (IMF) remarks.
Abu El-Fotouh pointed out that inflation is considered the biggest obstacle to the economic reform program implemented by Egypt in agreement with the IMF. The annual core inflation rate increased to 35.26% in July 2017, compared to 31.95% in June 2017. The annual general inflation also increased to 34.2% year-on-year (y-o-y).
“There is no doubt that this level of inflation is a major challenge for the CBE,” Abu El-Fotouh said.
He pointed out that Capital Economics—one of the leading independent economic research companies worldwide—explained in its report on Egypt that the Egyptian economy has passed the difficult stage. The report expected inflation to fall to 29% in 2017 and to 12.5% in 2018, reaching 8.5% in 2019.
Abu El-Fotouh added that the CBE is working on the treatment of inflation, through its different tools, so as to be able to influence the activities of banks and control credit conditions in order to control the volume of cash in the community.
Different tools to achieve the goal
Abu El-Fotouh explained that the tools of the CBE used to control inflation are divided into quantitative and qualitative control tools. He pointed out that quantitative control tools include open market operations, re-discounting process, and legal reserve ratio. These controls also include the size of the cash margin, and terms of credit financing for the consumer sector and real estate finance.
In response to a question about the ranking of Egypt in terms of inflation rate, Abu Fotouh said that there is no official list of current inflation rate in all countries of the world, but the current inflation rate of Egypt makes it in a relative high order. He pointed out that the rate of inflation in the South Sudan, for example, reached 361.9% by the end of June 2017, and reached 127.8% in Venezuela by the end of May 2017.
According to Ahmed Salim, the general manager of one of the banks operating in the Egyptian market, no one knows how the CBE will achieve its announced targeting inflation rate of 13% by the end of 2018. He wondered where the production that can meet consumption and lead to lower prices and low inflation will come from.
“In my opinion, this is inaccurate, because simply as our professors in economics summed up inflation in four words, a large amount of money chasing a small quantity of goods. If Egypt’s population is close to 100 million, can we increase supply in two years to make inflation reach only 10%. This this is too optimistic, and I am not convinced,” Salim said.
He added that it is true that there are factories in Egypt established for the production of goods, but there is also an increase in the population, and the sate cannot control the market and it cannot fight monopoly and greed, all of which increase inflation.
Why do we blame the CBE for everything?
In response to a question about the CBE’s ability to fight inflation, and if it can do it alone or with the support of the state, Salim said the problem is that we blame the CBE for many things. “How can the CBE fight inflation alone?” he said.
“We said that inflation is the balance of supply and demand for goods and services, and this is not available and not the business of the Central Bank of Egypt (CBE), and, therefore, there must be a complete system of trade, industry, agriculture, and finance and all the organs involved in production,” according to Salim.
“Targeting a certain level of inflation can be easy, but reaching the goal needs other achievements on the ground,” said Osama al-Manilawi, assistant director general of the finance sector at a local bank in the local market.
He pointed out that inflation in Egypt is very much linked to the dollar price against the Egyptian pound, so we should reduce the exchange rate first.
“We have to provide enough resources of foreign currency, which means that there should be sustainable cash flows, so as to avoid any fluctuation in the price of the local currency, as is happening now,” according to Manialawi
He pointed out that the state’s resources of foreign exchange are mostly coming from individuals and the hot flows that have recently been added to the reserves, which gives the impression of the fragility of these reserve, because they may be subject to sudden fluctuation in the desire of individuals to waive the transaction.
This issue, according to Manialawi, may affect the reserves in a short period, causing it to fluctuate completely at this sensitive period of the Egyptian economy. Thus, there is no immediate source of foreign exchange, except oil resources and discoveries, and other resources are subject to fluctuation like Suez Canal and Egyptian remittances.
As for the industrial base, which is the backbone of the resources of any country of the foreign currency, we are still in a very late stage.
“In conclusion, the better the position of foreign exchange inflows, the better inflation improves, and, therefore, in my personal opinion, and after reviewing the situation, I see that the inflation targets are subject to some exaggerations, especially as we are implementing the third phase of lifting fuel subsidies,” Manialawi asserted.
He added that wages are also of a special nature in Egypt, and it is very difficult to reduce them if there is an improvement in the economy, and since it represents a significant part of the cost of the product, we can not reduce that cost, which keeps the final price of the product as it is. Therefore, the improvement in inflation, if it occurs, will be gradual and not in this pace.
